Multinational corporations (MNCs) are the main participators in an increasingly integrated world economy in the 21st Century. With today's globalized economy and rapid progress in information technology, trade barriers are being removed, capital is moving across borders and around the world, access to information is instantaneous. As a result, economies are becoming increasingly interdependent.
As national borders become less relevant, business enterprises will be increasingly globalized in operational scale and mobile with regard to the location of their management and activities. While capital, goods and services increasingly move without regard to borders, national boundaries will continue to confine tax authorities. But these authorities will face certain challenges.
This does not mean that globalization has changed the fundamental goals of taxation policy. The national revenue needs to be met in a fair manner, taxation should maintain neutrality and minimize distortions and administrators need to limit compliance and administrative burdens to the greatest possible extent.
The challenge is how to tax the activities of international investors on a fair and neutral basis when their activities increasingly transcend borders.
This is best achieved by bilateral or multinational dialogues. Only through cooperation on an international level can administrations find solutions to the increasingly difficult taxation policy issues raised by globalization.
The global expansion of MNCs raises some special questions regarding the tax systems and policies of selected countries. Various taxation systems are practised around the world, and thus the taxation authority may have one opinion about a certain tax while the company executive may have another.
MNCs are taxed differently from one country to another. Some countries like the United States use an integrated system and levy a corporate income tax on all profits -- whether retained or distributed -- when levying taxes and also tax dividends received by investors. Germany practises a form of the separate system by levying a lower tax rate on distributed profits than on retained earnings.
Other countries like Austria, Canada, France and South Korea use the shareholder imputation system, under which the same tax rate is levied on retained and distributed earnings but the shareholder receives a credit for part of the corporate income tax paid on retained earnings.
There are also great differences in the extension of the tax laws, referred to as the source principal. The tax jurisdiction of economies with territorial assertion of their tax laws -- such as Panama and Switzerland -- extends only to profits made inside the company's country or area of domicile. The United States, on the other hand, adopts the nationality principal of the personal and corporate income tax laws and practises worldwide assertion, which means it can tax income regardless of where in the world the income is made by a natural person or company.
In some ways, MNC tax-payers and tax bureaux play a game resembling "cat and mouse." The primary company objective with taxes, as with any other expense, is to minimize their payment. The bottom-line for MNCs is to reduce foreign taxes as much as possible while avoiding controversy abroad as much as possible. The tax bureaux of both home countries and host countries need to encourage investment and prohibit tax arbitrage and tax evasion at the same time. They also must stop any behaviour that undermines the tax system or tax policy base.
One of the challenges posed by the tax system and tax policy base is tax arbitrage and evasion that involves the exploitation of differences in the tax laws of two or more jurisdictions because this results in the lowering of a taxpayer's worldwide tax liability by ensuring that income is not taxed anywhere.
Tax laws are written based upon certain assumptions, including fundamentally that income should not be subject to double taxation. In the cross-border context, this has been implemented through international conventions that have been widely adopted. Countries may characterize a transaction differently because of a variety of reasons including differences in rules with respect to ownership, entity characterization, instrument characterization, timing or source. By creating double non-taxation, tax arbitrage distorts economic behaviour because tax-payers will tend to favour cross-border tax arbitrage transactions over domestic transactions or other types of cross-border transactions, thereby undermining the principle of neutrality. Furthermore, tax-payers who do not have access to arbitrage opportunities will have higher costs of operations and will thus be prejudiced because they will not have the benefit of such de facto subsidies.
Another challenge to national and international tax systems and policies comes from the emergence and development of the Internet and e-commerce. Tax administrations face the challenge of adapting existing tax systems to an economy that increasingly ignores physical borders and that increasingly operates under new business models. And under new business methods -- such as the Internet, corporate Intranets and other communications and service delivery advances -- it is more difficult to determine where the services have been performed, thus increasing the opportunities for manipulation and tax avoidance.
In order to best respond to these challenges, tax administrations should provide a fair environment in which e-commerce can flourish, while at the same time ensure that the Internet does not become a tax haven that undermines the tax systems and their functions.
At present, the Organization for Economic Cooperation and Development (OECD) and non-OECD partners are working in building an international consensus on the framework underlying any taxation of e-commerce with a fundamental principle that any taxation of the Internet and electronic commerce should be clear, consistent, neutral and non-discriminatory.
Financial innovation -- especially the new financial instruments, products and services created recently -- is an excellent example of the issues with which current tax systems are concerned. Traditional tax rules that address the proper treatment of holders and issuers of financial instruments are not applicable to certain financial instruments and services that have been developed in recent decades. For instance, a forward contract, a futures contract and the combination of a written put and a purchased call may all produce the same exposure to changes in the price of some underlying position, but all have different tax consequences. Many of the instruments traded on today's markets may not comfortably fit under the current rules. What is needed, therefore, is a fundamental re-examination of the taxation of financial instruments with the goal of making the rules more consistent and more economically sensitive. The new comprehensive rules and guidance should also treat similarly situated financial products and tax-payers equally.
All these challenges to national tax systems and international tax policy demonstrate the importance of international co-ordination in this increasingly borderless business environment. Such co-ordination is necessary to set minimum standards for the operation of tax systems, while at the same time preserving the right of each country to choose its own tax system to the greatest possible extent.
The author is a professor of economics at Shandong University.
( May 31, 2002)
